Working Paper: CEPR ID: DP872
Authors: Lars E.O. Svensson
Abstract: This paper discusses what we have learned from last year's currency crises in the ERM and Nordic countries about fixed exchange rates as a means to achieve price stability. After discussing the explanations for the crises, the paper concludes that fixed exchange rates are not a short cut to price stability. Monetary stability and credibility have to be built at home and cannot easily be imported from abroad. Fixed exchange rates are more fragile and difficult to maintain than previously thought. They may even be in conflict with price stability, by inducing a procyclical destabilizing monetary policy, and by inducing an inflation bias. Building monetary credibility is even more important with flexible exchange rates.
Keywords: fixed exchange rates; price stability; ERM
JEL Codes: F31; F33; F41; F42
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Fixed exchange rates (F31) | Procyclical monetary policies (E52) |
| Fixed exchange rates (F31) | Economic instability (E32) |
| External shocks (increased capital mobility) (F32) | Vulnerability of fixed exchange rate systems (F31) |
| Asymmetric shocks (F41) | Real exchange rate adjustments (F31) |
| Real exchange rate adjustments (F31) | Economic tensions (N14) |
| Economic tensions (N14) | Undermining credibility of fixed rates (E43) |